Plunging Currencies Complicate Inflation Fight

Just because markets are crashing doesn’t mean inflation is going away. In fact, the situation could be getting worse due to falling currencies.

Singapore reported Friday that consumer prices rose 5.7% in the year ending August, faster than the 5.4% rate in July. The Singapore dollar meanwhile is down nearly 8% this month against the U.S. dollar. A weaker currency makes imported goods, especially commodities priced in dollars, more expensive, adding to inflationary pressures.

A similar scenario is playing out elsewhere. Inflation remains elevated in Brazil, India and South Korea, and now it will get a boost from plummeting currencies. Since the start of September, the greenback is up 19% against the Brazilian real, 18% against the South African rand and nearly 9% against the Korean won. It’s up more than 7.5% against the Indian rupee.

To be sure, there has been some relief on the commodities front in the past couple of days, with copper and oil dropping. But these commodities are notoriously volatile and could rebound quickly.

And even if they don’t rebound, inflation is bad enough in some places, such as India, that these countries will now miss out on what could have been a surprise inflation-relief valve.

A weakening rupee “raises the inflation almost automatically,” says Abheek Barua, chief economist at HDFC Bank Ltd. Most commodities imported by India, particularly oil, are denominated in dollars, making these expensive for India.

“The recent fall in global commodity prices is now mostly offset by the depreciation in [the rupee] and thus is unlikely to provide the much-needed and anticipated relief on imported inflation front,” writes Jay Shankar, chief economist at Religare Capital Markets. He like, many commentators in India, is calling on the central bank to intervene in currency markets to mute the imported inflation effect.

Elsewhere, there are still signs emerging economies are running near full steam and that inflation could persist should domestic demand hold up in the face of slowdowns in the U.S. and Europe. Hong Kong, Brazil and South Korea reported strong jobs numbers this week, with Hong Kong’s unemployment rate hitting 3.2% in the three months ended August, its lowest point since the Asian financial crisis in early 1998. Hong Kong said Thursday its consumer prices in August rose 5.7% in August, down from July’s 7.9% but still considered elevated.

“Inflation is worryingly sticky,” Frederic Neumann, economist for HSBC in Hong Kong, recently wrote. “There is no clear evidence that price pressures are easing.” He notes that core inflation in China, which excludes volatile food and energy, is at a 14-year high.

‪Mr. Neumann says the usual tonic for inflation — slower growth — won’t help as much in Asia this time because of the way Asia’s economies have shifted in recent years. There’s less empty manufacturing capacity than in previous cycles. And the shift toward long-term construction-related investment as a growth driver means price pressures will persist longer, as it takes time for projects to wind down. In the past, a drop in exports meant companies would simply stop producing goods, relieving price and wage pressures.

One solution to the falling currency problem is for central banks to intervene in currency markets. But the effect of those interventions can be limited when markets experience massive capital flow reversals, as is currently occurring. Indonesia, South Korea and Brazil have all intervened in recent days, but the effect has been more to slow depreciation somewhat, not stop it or reverse the trend.

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